Indirect Taxes in Nepal : Challenges and Trends

The incidence of indirect taxes has generated several important concerns including the impact on the poor, fulfillment of the objectives of indirect taxes, and corruption in tax administration.

At 22.2 percent, Nepal's tax-to-GDP ratio is already comparable to that of developed economies. However, unlike the developed economies, Nepal depends mostly on indirect taxes.

According to Harvard economist Daron Acemoglu, tax revenue as percentage of GDP is generally higher among countries with higher per capita income. Nepal is an anomaly in the global trend. For a country with modest economy, Nepal displays a strong state capacity for taxation. For example, Nepal's tax to GDP ratio has grown in recent years—it increased from 15.9 percent in FY2014/15 to 22.2 percent in FY2017/18—and is comparable to that of high-income countries.

However, in FY2017/18, some of the indirect taxes like VAT, excise and customs alone constituted 64 percent of the total tax revenue.

The incidence of indirect taxes has generated several important concerns including the impact on the poor, fulfillment of the objectives of indirect taxes, and corruption in tax administration.

According to the definition of economist Anthony Barnes Atkinson, direct taxes can be adjusted to the circumstances of an individual taxpayer while indirect taxes are imposed blindly on transactions without taking into account the characteristics of the buyer or the seller.

Impact on the poor
One of the major debate is over the impact of indirect taxes on the poor.

Speaking at a recent public event, Professor of Economics at Tribhuvan University, Binaya Kumar Kushiyait, said the government's move to increase indirect taxes will increase inflation and have negative impact on public welfare. He said the government has increased indirect taxes while the share of direct tax remains at a meagre 30 percent.

Vidyadhar Mallik, former Minister for Health says that increasing incidence of indirect taxes has a negative impact on people living around the poverty line, who may have to pay a higher proportion of their total income for consumption.

"Given its economy, Nepal cannot do without tax on consumer goods, customs and excise. However, it would have been better if the incidence of tax on basic consumer goods was lower," mentions Mallik who also worked as the finance secretary in the past.

Finance minister Dr Yuba Raj Khatiwada agrees. "Indirect tax does not see whether a person is rich or poor. The tax administrator needs to use reason and try not to impose indirect tax on goods consumed by the poor," he says.

According to Dr Khatiwada, the country is dependent on indirect taxes in the medium term, until the economy develops. "Our tax base is not so broad enough that we can depend solely on direct taxes," he said. "Once the economy develops, we can gradually decrease the scope of indirect taxes and adjust the customs tariffs and excise duties."

He says indirect tax affects the ordinary people but there has been no change in the rates of indirect taxes. He says adjustment in the taxes for luxury goods and items that harm health and environment does not really affect the people.

Do indirect taxes in Nepal meet the objectives?
According to experts, the primary objectives of indirect taxes are to generate resources for investments in public goods or to redistribute wealth, to correct weaknesses of the market, and to protect national economy.

According to IRD, one of the objectives of VAT is to increase the contribution of indirect tax in the tax share. The strategy has largely worked. Indirect taxes contribute two-thirds of the total tax revenues. In FY2016/17, excise duties, VAT and customs tariffs contributed Rs 444 billion, while the total tax revenue was Rs 666 billion.

However, while the indirect taxes generate a significant amount of revenue, investments in public goods and redistribution of wealth have suffered from irregularities in tax administration and corruption at the policy-making levels.

Ministry of Finance is frequently high on the watch list of the Office of the Auditor General (OAG) because of "irregularities reported in non-recovery of capital gains tax, non-declaration of actual amount of purchase and sales transaction, non-collection of VAT, credit claim of ineligible VAT, and non-payment of taxes despite transactions in excess of crores of rupees."

Given the high levels of corruption, the state is also struggling to tax higher earners. Indirect taxes may have also failed to correct the market or provide stimulus to businesses. According to Mallik, the government depends excessively on excise duties and customs revenues—and indirect taxes on imported goods—for revenues, and as a result it has been unable to promote productivity and doing business environment in the country.

VAT system, normally, would allow businesses to reclaim VAT they have paid on inputs, thus stimulating domestic production. According to experts, an effective return system is essential if VAT is to work well. However, VAT returns have become a primary source of corruption in Nepal.

Tax administration of indirect taxes, including VAT, has become extremely problematic. The OAG, in its 2017 report, pointed out several concerns including the prevalence of under-invoicing at the customs, collusion between tax administrators and tax-payers to avoid taxes, and irregularities in VAT returns. According to the OAG report, until FY2016/17, the total revenue that remained uncollected stood at Rs 132 billion, which increased to Rs 161 billion in FY2017/18. Most of these revenues (about 84 percent) were related to taxes. The Ministry of Finance refused to declare the amount of VAT that remained to be collected so the OAG was unable to verify the amount.

The 2017 OAG report states, "On the one hand, regular taxes are not being raised from industries and businesses, and on the other hand, the amount paid by the ordinary citizens as VAT is not being received by the government. Such tendency is posing an open challenge to the law."

This situation persists despite efforts by the IRD to streamline tax administration through the use of technology. In order to improve tax collection, the IRD started to track computerised billing system of vendors with its own centralised server from November 2017. It began with storing bills issued by large hotels and auto-traders.

There are about 187,000 registered companies in Nepal and about 184,356 are in the VAT net, while 184,356 have registred for excise. However, a large chunk of them, about one-third, are non-filers. Government officials believe a large chunk of taxpayers collect VAT from the consumers but do not submit it to the government.

Another major issue is the practice of under-invoicing at the customs. Although the importers collect VAT on the actual bill amount, they are only obliged to pay what they declare at the customs. The issue of VAT returns became so problematic that the government of Nepal has cancelled the provision of providing VAT rebate to businesses. Finance Minister Dr Khatiwada announced during budget speech that he had "repealed the current provision of direct refund of Value Added Tax amount that collected from the consumer to the registered taxpayers" as well as the VAT paid by mobile phone importers.

According to him, the VAT rebate was repealed because it was unable to ensure how much VAT the people have paid, whether there have been value additions, or how much the government should return. Instead, the government has decided to provide direct grants to agro producers.

"Taking back the provision of VAT returns means that the businesses cannot appropriate taxes paid by the citizens, which is not a subject of great concern for the citizens," he says.

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